DISCUSSION PAPER PI-0005
Measuring Value Added in the Pensions Industry
David Blake (Birkbeck College, London)
John Board (Financial Markets Group and Department of Accounting
and Finance, London School of Economics)
The providers of personal pension plans, such as life assurance companies,
extract charges from the contributions they receive from policy holders.
These charges pay for plan administration, profit and key services (such
as fund management). There is an ongoing debate as to whether personal
pension plans deliver investment returns which are high enough to justify
these charges. A related matter is concerned with how to report the likely
future payoff from a plan so as to allow consumers to choosebetween
The objectives of this paper are to survey and analyse the charges, realised
investment performance, and expected investment performance of personal
pension plans in the UK; to use modern finance theory and practice to assess
whether it is possible to identify a relationship between these three factors;
and, if such a relationship exists, to provide a method for reporting it in way
that consumers can easily understand.
We find that, on the basis of existing evidence, there is no clear relationship
between the three components. In particular, we find that there is no support,
either in theory or in practice, for the argument that high charges can be justified
by the promise of the superior investment performance that such high charges
might be able to purchase. This is because the evidence indicates that strong
investment performance, even if it existed for a period in the past, is very unlikely
to be sustained over the long investment horizon needed by pension plans to
build up sufficient assets for retirement.
The current complex and often disguised charging structures used by providers
is a source of consumer confusion. In addition, the personal pensions industry in
the UK suffers from very high lapse rates by policy holders. We propose a new
method of reporting charges that reflects the effect of these lapse rates. We suggest
that the best approach to adding value in the pensions industry is the greater use
of performance-related charges by both providers and those delivering critical
services to providers (for example, fund managers). Such charging methods will
improve the incentives for providers to ensure the long term commitment of their
policy holders. But even if such incentive structures are not developed independently
within the industry, there is now major pressure from the UK government to improve
the value added by the pensions industry.
The structure of the paper is as follows: charges, realised investment performance
and expected investment performance are discussed in the next three sections and conclusions are drawn in section 4.